TCJA changes rules for pass-through business losses

It’s not uncommon from time to time for businesses to generate tax losses. However, the losses that can be deducted are limited by tax law in some situations. Beginning in 2018, the Tax Cuts and Jobs Act (TCJA) further limits the amount of losses that partners, limited liability company (LLC) members, S corporation shareholders, and sole proprietors can currently deduct, this could become problematic for owners of start-ups and businesses facing adverse conditions.

Before the TCJA

An individual taxpayer could, usually, entirely deduct business losses in the tax year when they arose under the pre-TCJA law, unless:

  • The passive activity loss (PAL) rules or some other provision of tax law restricted that fortunate outcome
  • The business loss was so significant that it surpassed taxable income from other sources, creating a net operating loss (NOL).

After the TCJA

The TCJA momentarily changes the rules for deducting an individual taxpayer’s business losses. You cannot deduct an “excess business loss” in the current year if your pass-through business creates a tax loss for a tax year starting in 2018 through 2025. An excess business loss is the surplus of your collective business deductions for the tax year over the sum of:

  • Your cumulative business income and gains for the current tax year
  • $250,000 ($500,000 if you’re a married taxpayer filing jointly).

The rules for NOLs allows you to carry over to the next year and deduct the extra business loss.

The new excess business loss limitation rules apply at the owner level for business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes. In other words, each owner’s assigned share of business gain, income, deduction or loss is passed through to them and reported on their personal federal income tax return for their tax year that includes the end of the entity’s tax year.

Realize that the new loss limitation rules apply after applying the PAL rules. So, you don’t get to the new loss limitation rules if the PAL rules prohibit your business or rental activity loss.

Expecting a business loss?

The reason underlying the new loss limitation rules is to limit individual tax payer’s use of current year business losses to offset income from other sources, such as capital gains, salary, self-employment income, dividends, and interest.

The applied impact is that your allocable current-year business losses cannot counteract more than $250,000 of income from similar sources (or more than $500,000 for joint filers). The obligation that surplus business losses be carried onward as an NOL forces you to wait at least one year to get any tax gain from those extra losses.

Contact us if you’re expecting your business to generate a tax loss in 2018, we can help you to determine whether you’ll be affected by the new loss limitation rules. We can also answer any questions about the PAL and NOL rules.

© 2018
Ben R Shull CPA LLC provides clients with tax, transaction, and advisory services. The insights and quality services we deliver help lead our clients through the next generation of changes, and accelerate growth while reducing risk. CPA Katy, TX.